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International Financial Management
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Introduction
This essay will discuss the operation of BMW --- a multinational automobile maker. As
a multinational corporation, BMW is operating in different countries what the market
differs one from another. In order to succeed, BMW has to adopt the financial market
and make use of favorable conditions. This essay will firstly discuss the global financial
environment that BMW operates in. The analysis of global financial environment will
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first present an overview and then examine the situation of the main markets of BMW.
After that, there will be a description of international monetary system and how that
will effect exchange rates (Al-Shboul, 2014). Secondly, it will introduce three types of
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exchange risks and how BMW suffers from these risks. Thirdly, the essay will discuss
the strategies that BMW adopt to deal with the risks. Lastly, the effect of these strategies
will be evaluated.
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Global financial environment that BMW operates in
The global economy grew in the past few years. For MNCs, being international is
beneficial from the following aspects. The global financial environment is suitable for
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MNCs to become international. Firstly, as we know, high expect rate of return always
means high risk. The purpose of the company is to maximize the value of shareholders.
Companies always have a set of opportunities, each has an expected level of return and
risk. When a company becomes international, it will have an extended set of
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opportunities. In that case, the resources may be better allocated and risks may find its
way to be dispersed. It is also possible that all of the domestic opportunities are not on
the efficient frontier. So as a result, diversification across counties will lower the risk.
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This is called the portfolio effect. Second, there is comparative advantage. It is common
that two companies from two different countries are competitors (Carrasco, 2004).
However, unlike domestic companies, MNCs can benefit from theses kinds of
competition. This is a classical argument that appeal for free trade in which case the
comparative advantage can be better utilized (Carrasco, 2004). Assuming the US
manufactures are better at producing high-tech products such as the Iphones and China
manufactures are better at making clothes. If both of the two countries have to product
the Iphones and clothes by themselves, they may cost more if they want to enjoy the
same kind of quality or technology of the products. There is another example about
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Ford and Toyota, they seem to be direct competitors and it is reasonable to think this is
a zero-sum game. However, the two countries --- America and Japan are also benefit
from the competition between Ford and Toyota. Ford is better at producing automobiles
with great power and high acceleration because many Americans enjoy that. On the
other hand, Toyota is better at producing efficient cars with low-energy consumption.
Both of the two companies are experts in their areas and different customers have
different needs, so the combination of them satisfies more customers while they can
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still concentrate on their strengths and making profits. Thirdly, the MNCs can make use
of the internationalization advantage. Why do so many companies import while others
extend the market overseas. Many companies want to be part of the world market and
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that means they have to build base in other countries. The trend of internationalization
has made it possible for companies to invest directly overseas (Patro, 2002). To take
advantage of internationalization, companies will better have two kinds of advantages:
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location and ownership. Fourthly, the global financial environment allows for
economies of scale. Economies of scale is a synergistic effect, which takes place when
the whole is worth more than the sum of its parts (Patro, 2002). For example, the
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company invest 50,000 pounds into development of a new products and the average
cost is 5 dollars per unit and there is a fixed cost of 50,000 pounds. The company can
only sell 10,000 units in its own countries. In that case, the average cost per unit is 15
pounds. However, if the company sells its products in different countries, let us say, the
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sales volume is 50,000 units. In that case, the average cost of a unit is 7 pounds which
is much less than 15 pounds. Besides, the companies may be able to find a production
location with cheaper labor and materials to further lower the cost of product.
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Investment in other markets and sell products in the global market will allow the MNSs
such as BMW to gain greater synergistic effect.
BMW has its business operated in many countries, among which the USA, China are
very important markets. In 2015, the US economy grows in a record rate while China
decides to grow in a more stable and safe way with record low growth rate since 1990.
The growth rate of China is lower than that of the past years although it is still one of
the countries which have the highest growth rate in the world. China is the primary
marketing for BMW, as China is holding down its growth rate and many cities in China
have adopted limitation of license plate because of traffic jams and worsening
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atmosphere. So the sales volume in China may be largely effected in a few years.
Besides, the US has a growth rate of 2.6 percent in 2015, as the superpower country in
the world, it may influence the growth rate of many other countries in a positive way
(Slowik, 2012). Japan has a growth rate of 0.6 percent in 2015, the growth potential in
Japan is kind of weak, so it is hard to promote further of BMW in Japan (Slowik, 2012).
As for India, it has a higher growth rate than China while other BRIC countries still
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perform badly (Slowik, 2012). Another big country--- Russia is still struggle to develop
its economy. Although BMW has achieved a high growth in sales volume in 2015, the
prospect is not optimistic and that may explain why BMW is producing cars which
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are cheaper and more energy-efficient. BMW is now completing with more lowerended brands. Of course, BMW may always have the plan to expand its target customers
in order to share a larger market. So although some of the main markets for BMW is
products and enter new markets.
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not so optimistic, it may have ways to deal with that situation such as extend the
The international monetary system is the system of the rules that govern the use and the
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exchange of money in the world or among countries (Seldon, 1999). Every countries
has its own official currency and that is why there is a issue of exchange rate. In the
19th century, the main economic center is in Europe and US. The different markets in
the world are loosely related and the exchange rates are not so influential
(Seldon,
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1999). In the past few decades, almost all the countries including Japan, China, Russia
and India have experienced dramatic changes in exchange rates which have great
impact on their economies. Although the Bretton Woods Systems have been set and the
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systems do contribute to the stability of the world economy, exchange rate risks is still
a very serious risks for the MNCs including BMW. This issue will be further discussed
in the next sectors.
Foreign exchange risks
This part is going to discuss three kinds of exchange risks and how BMW may suffer
from these three kinds of risks. Exchange rate risk has always been important issues of
concern to MNCs (Iorio, 2001). Due to the ever-changing foreign exchange market,
then the business will inevitably suffer from the risks. There are three main kinds of
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exchange risks --- transaction exposure, operating exposure and translation exposure.
Transaction exposure is the most common risk, as long as the business process are
related to foreign currency transactions, trading risk can occur, such as the simple
import and export transactions (Kim, 2015). Foreign exchange risk refers to the risks
that may arise the planned, under progressed or completed transactions. Since the actual
profit and loss of these services depends on the prevailing level of the nominal exchange
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rate, it is difficult to predict what changes may occur within a certain time so that their
actual income and expected income, expected costs and actual cost may departed
(Shawn, 2014).
transaction risk of foreign currency transactions refers to actual profit
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and loss, thus the transaction will directly affect the net cash flow (Shawn, 2014).
Operating exposure refers to unexpected movements of exchange rate which will effect
may suffer a potential loss.
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the cost of production, sales, prices and costs so that the future earnings or cash flow
Translation exchange rate risk are also known as the accounting risks, refer to balance
currency. It is
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sheet accounting of economic when converted to the functional currency to recording
possible there will be book losses due to exchange rate changes. The
translation exposure is not related to flow of cash flow so there is no actual need to deal
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with the translation risk as far as I concerned.
By 2011, only 17% of the sales volume of the cars sold by BMW was sold in Germany
(Loch, 2001). As for China, it brought more cars than people in Germany did in 2015
(Loch, 2001). Besides, Russia, the eastern Europe are also very important markets for
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BMW. It is obvious that the profits of BMW are always eroded by the risks caused by
exchange rate risks (Loch, 2001). From the calculations of its annual reports, it can be
learned that the losses raised by exchange risks totaled nearly 2.4 billion euros from
2005 to 2009 (Loch, 2001).
There are two main ways that can be used to deal with the losses caused by exchange
rate risks. One is to pass the costs to consumers and that is a way Porsche had adopted
to deal with the exchange rate risks. The other is to diversify the risks and lower the
costs by the company itself and that is the way BMW decided to use.
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BMW’s strategies to manage the exchange risks and the functions of strategies
This part will discuss the strategies that BMW uses to manage the exchange risks. There
are two main approaches. The first one is to use natural hedge which means it will
match the currency of
revenues to the currency of costs. When both the revenues and
costs are in local currency, the amount of capital that is exposed to exchange risk will
be much smaller (Bahmani-Oskooee, 2008).
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However , it is hardly possible to avoid all the exchange risks by natural hedge. So
BMW still uses other financial hedges and build up regional treasury centers in some
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financial centers such as US, UK and Singapore.
The natural hedge can be implemented through two methods. First, it establishes
factories in the countries where it sells its cars. The second involves make more
purchase of goods and materials that denominate in the local currencies (Johansson-
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Stenman, 2006).
Now BMW has production bases for cars and components in 13 countries (Johansson-
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Stenman, 2006). By time of 2011, 44 percent of the products are produced overseas.
BMW had set its plant in the US in 1990s and that made the supply chain shorter. This
move in US has created more than five thousand jobs in America and much more jobs
are cut in Germany. As a result, the company’s sales boosted in US and it has more
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revenues in dollars and the number continues to raise. That is to say a large part of the
risks raised from the changes between US dollars and euros are avoided in this way.
There is also a joint venture made between BMW and the Brilliance Automotive in
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China (Bartram, 2006). Half of the cars sold in China is made there. So a large portion
of the exchange risk between RMB and euros are avoided
(Bartram, 2006). Besides,
large portion of the materials used to manufacture cars in China are purchased from
local suppliers. This move does not only shorten the production line and supply chains,
but also make the price of cars lower and as a result more people can afford BMW cars
and the sales will increase because of that (Bartram, 2006).
What is more, the regional treasury centers are required to stare at the exchange rate
exposures every week and make a report to the lead of the center. The leads will
consider all the risk exposures and figure out a plan to mitigate the risks (Slowik, 2012).
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It can be concluded that BMW has found a way to deal with the exchange exposures
and the strategies are effective to lower the losses. Besides, the strategies BMW used
to deal with exchange risks also help it lower production costs, make more sales and
offer better services.
Conclusion
In conclusion, this essay firstly critically examines the issue of exchange rate risks.
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BMW is an international company which has been found for almost a hundred years. It
is operated in a global market which is favorable for companies to become international.
Although some of the main markets of BMW have suffered from decreases of growth
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rates or even negative growth rates, BMW is positively deal with the situations through
ways such as extension of markets and lower-ended products and it keeps increasing
every year. Besides, BMW is exposed to foreign exchange risks because it operates in
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a global market. BMW suffered a lot from foreign exchange risks. Now it uses two
ways to deal with the risks and as we can see from the results of the strategies that the
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those markets.
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strategies are useful and lay a solid foundation for the further development of BMW in
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